Editor’s note: I was interviewed on KSL’s Sunday Edition with Doug Wright last week. The discussion about Ponzi Schemes and affinity fraud in Utah happens at 8:18. I appreciate KSL Television’s willingness to engage in a frank discussion about why affinity fraud is a particularly vexing problem here in Utah, and to help get the word out on how to prevent these scams.
Editor’s Note: This is an interview I did yesterday for the “Trib Talk” podcast from the The Salt Lake Tribune .
The sentencing of convicted fraudster Rick Koerber was delayed — again — this week, adding another chapter to a 10-year legal saga for one of Utah’s most notable Ponzi schemes.
But while the Koerber case is unique for its circuitous route to justice, Koerber’s underlying crimes and use of religion to target victims, are relatively common in The Beehive State, according to national statistics and the experience of local attorneys.
On this week’s episode of “Trib Talk” Tribune legal affairs reporter Jessica Miller and Salt Lake City attorney Mark Pugsley join Benjamin Wood to discuss Utah’s high rate of Ponzi schemes and why the state’s residents are particularly vulnerable to affinity fraud.
I frequently speak to groups about investment fraud and one of the questions I often get asked is whether it’s true that Utah has the highest rate of Ponzi schemes and affinity fraud in the country.
In the past I haven’t been able to say for sure. There aren’t any good studies that have reached that conclusion, and so I have to just rely on anecdotal evidence.
Well, now we have proof. Jordan Maglich, who runs the website PonziTracker.com, just released an epic ten-year survey of Ponzi schemes in the United States. He found that there were over 800 Ponzi schemes reported publicly from 2008-2018 and that they collectively caused a jaw-dropping $60 billion in financial destruction. I believe this is the first database compiling publicly-reported Ponzi schemes and sentences during the “Madoff Era.”
And the survey contains very bad news for Utahns. Utah had the sixth-highest number of Ponzi schemes despite ranking 31st in population. So when I ran a per-capita analysis of the numbers Jordan reported it turns out that Utah has the highest rate of Ponzi schemes per capita in the country by far, at 1.35 Ponzi schemes per 100,000 people. And the next highest state (Florida) is nearly two thirds lower at .51 per 100,000 people. (Chart)
If you take out the massive Madoff Ponzi scheme in New York ($17 billion), Utah also has the highest loss per capita of $502 per person – which is more than double the next highest state!
Overall, Utah investors lost over $1.5 billion to these schemes in the last ten years. And that number does not include other affinity frauds and other investment scams which undoubtedly account for another $500 million in losses to Utah residents over the last ten years (at least).
How would $2 billion benefit our economy? What is the collateral impact of these scams? Here are a few thoughts:
- Millions in state and federal resources are consumed by the victims of fraud who no longer have means to support themselves in retirement, including paying their medical bills and other living costs.
- The families of fraud victims often have to step in to house and support their parents or children who have been wiped out financially.
- Banks, investment advisors and stock brokers lose significant revenue when people liquidate their IRAs and 401K to invest with some unlicensed scammer.
The list goes on…
Why is Utah’s problem so much worse than any other state?
This is a complicated problem, and there is no clear answer. But after helping people recover losses from investment fraud for 25 years my view is that people in Utah are simply too trusting, particularly when the person soliciting an investment is in their ward or shares their religious affiliation.
If someone pitching you an investment casually mentions that they used to be the bishop or in some other church position, watch out! Church callings and temple worthiness are not relevant to investment decisions, so beware of those who bring these issues up in an investment pitch.
Also, it may seem like doing business with someone you know and trust would be safer, but that is simply not true. All investing involves risk, and just because you trust the individual soliciting the investment does not mean that the investment itself is good. Trust but verify; and if things go badly do not hesitate to aggressively protect your interests.
Finally, investment decisions should never be made based on feelings. Just because it feels legitimate, or feels like a good idea does not make it so.
Here are a few things you can do to avoid getting scammed:
Do your homework. Run a simple Google search on the company and its managers, or the individual pitching the investment. You might be surprised by what you find.
Hire an attorney. An experienced lawyer can help you perform due diligence into the company and individuals offering a private investment. You need to carefully evaluate the risks and determine whether the offering complies with state and federal statutes. It is far cheaper to hire an attorney on the front end of an investment like this – when your money is gone it gets very expensive.
Get it in writing. I am amazed how often people will give hundreds of thousands of dollars to someone on nothing more than a handshake. The terms of your deal should always be put in writing, and those terms should be reviewed by the competent attorney you hired.
Read the Paperwork. Investors in a private investment opportunity should receive a detailed lengthy disclosure document called a private placement memorandum (PPM). Take the time to review it before you invest. Like a prospectus, a PPM contains detailed information about all aspects of the business including the business model, financial history, risk factors, biographical information on the managers, and the terms and conditions of the private investment, among other things. If you don’t understand these things, hire a professional who does.
Work through licensed stock brokers or investment advisors. Even private (unregistered) investments generally need to be sold by licensed stock brokers. Every investor should look at the employment and disciplinary history of their broker or investment adviser, which is available on FINRA’s BrokerCheck website.
And most importantly, if it sounds too good to be true it probably is. If you are thinking about putting money into an alternative, unregistered, or unusual investment that promises abnormally high returns (like anything higher than 10 to 15% per year), watch out. And if someone promises you a “guaranteed” return on any investment that ought to be a red flag — investments are rarely guaranteed and investments that offer unusually high returns are more risky, not less.
|State||Population||Schemes||Schemes per 100,000 people||Total Losses||Losses per capita|
|*New York (without Madoff)||19,849,399||89||0.45||$4,307,050,000||$216.99|
NOTE: The per capita analysis in this table is mine. The underlying data comes from this website: Ten Years After Madoff, Updated Ponzi Database Shows Schemes Are Thriving
Copyright © 2019 by Mark W. Pugsley. All rights reserved.
Recently I have been busy working to recover losses for a large number of investors who lost money in unregistered investments offered by Woodbridge and Future Income Payments or FIP. In many cases these investments were recommended by insurance agents who were not licensed to sell securities, and did not perform adequate due-diligence on these companies before they made the recommendation.
FIP offered pensioners upfront, lump-sum payments in return for a portion of their monthly pension payments over a specific term, often three to five years. FIP then used these pension payments to fund a monthly income stream back to the investors who put up the money for the lump-sum payments. In July of 2018 Scott Kohn, the 64-year-old felon who started the company, closed the doors and disappeared leaving investors with more than $100 million in losses.
Subsequently the SEC filed charges against thirteen individuals and ten companies who recommended and sold Woodbridge, including Utah-based Aaron Andrew and Live Abundant. Live Abundant and its agents were not licensed to sell securities, and yet they recommended both FIP and Woodbridge to hundreds of people here in Utah and throughout the western United States. Our lawsuits against Live Abundant and the individuals and entities who perpetrated this scheme are ongoing.
The common link between these two fraud schemes is that investments in FIP and Woodbridge were not registered with the SEC. These are sometimes referred to as private placements or unregistered offerings. Generally, a company may not offer or sell securities in the United States unless the offering has been registered with the SEC or an exemption from registration is available. For more information about exempt offerings I recommend you look at this article on the SEC’s website.
Below is a repost of an article from Investment News that highlights some of the challenges for individual investors from these investments, and for the firms that offer them.
Sales of Unregistered Securities are a Growing Problem That’s Harming Investors — and the Industry
By Bruce Kelly
To an investor, Castleberry Financial Services Group’s promise of up to a 12.2% annual yield on the alternative investment fund it was selling might have seemed awfully tempting. So might the assurance that your principal would be insured and bonded by well-known insurance companies CNA Financial Corp. and Chubb Group.
In promotional materials, Castleberry claimed to have invested almost $800 million in local South Florida companies and to have a portfolio of real estate holdings that was generating $2.8 million in rental income annually.
But in late February, the Securities and Exchange Commission went into court to shut the company down, claiming it was all a fraud, including the involvement of CNA and Chubb.
Before the SEC acted, though, it said that Castleberry had managed to raise $3.6 million from investors, some of which was used to pay the personal expenses of its principals. Other funds were transferred to family members or other businesses the principals controlled, according to the SEC.
By all indications, the marketplace for all types of private, unregistered securities, including private placements sold to wealthy investors and institutions, is thriving. But what’s growing alongside this legitimate, if risky, market is a seedy side of the financial advice industry. Investment funds promising above-market returns that employ networks of brokers, former brokers, insurance agents or others lurking on the fringes of the industry to sell their investments are taking advantage of unsuspecting investors.
Add in the ability to offer private securities over the internet and solicit clients via social media, and unregistered, private securities being sold to less-than-wealthy investors, many of them senior citizens, are becoming increasingly dangerous. Fraudulent securities are damaging the reputation of the legitimate financial advice industry, and the industry itself might serve as the best solution to safeguarding the investing public.
“I’m seeing more of it: the spike in the sale of nontraditional investments,” said David Chase, a former SEC staff attorney who’s now in private practice and based in South Florida.
The proliferation of potentially fraudulent schemes comes at a time when the sale of legitimate private securities, which are exempt from having to be registered if they meet certain SEC guidelines, has taken off. While the annual amount of public stock offerings has remained relatively steady over the past decade, the sale of new private stock offerings has soared.
The most popular of these, known as Regulation D offerings, have more than doubled, from 18,295 in 2009 to 37,785 in 2017. Those deals, along with other types of private offerings, raised a total of $3 trillion in 2017.
Brokers and advisers can sell private, unregistered shares to only the wealthiest clients; investors need a net worth of $1 million or an annual individual income of $200,000 to buy in. But the public disclosure is negligible, making the securities opaque, some sources said, and that is hazardous.
The game plan of the fraudulent unregistered securities schemes currently roiling the investment advice market is simple. An investment manager claims to have an alternative investment to the stock market that beats the return on bonds or bank deposits. The investments are heavily marketed with investment seminars, dinners, and ads on radio and in local newspapers.
James Park, securities professor at UCLA, said the internet is giving the promoters one more outlet to sell their fraudulent investments.
“It’s now possible to get investors from everywhere,” he said. “In the old days, brokers would have to call up people to convince them to invest or put on a road show. Now it’s normalized with online platforms.”
In one of the largest recent cases, the SEC said the owners of Woodbridge Securities raised $1.2 billion over a five-year period by claiming they were selling loans to real estate developers.Source: North American Securities Administrators Association
Promising returns of 10%, the scheme reeled in 8,400 investors, many of them senior citizens, with the help of a network made up mostly of insurance agents and former stock brokers, according to the regulator. Woodbridge’s owners kept the scam going, the SEC said, by using money from new investors to pay off old investors — a classic Ponzi scheme.
Without admitting or denying the allegations, Woodbridge and its former CEO Robert Shapiro settled with the SEC for $1 billion in disgorgement and fines. Ryan O’Quinn, a lawyer for Mr. Shapiro, did not return a call seeking comment.
Beyond FINRA’s reach
One of the reasons these cons take time to detect is because the agents selling them mostly work outside the supervision of licensed broker-dealers, who are under the purview of the Financial Industry Regulatory Authority Inc. This gives the fraud ample time to flower before the SEC or a state regulator gets a complaint from an investor, investigates and shuts it down.
“The largest Ponzi schemes in general are those that have tapped into a very successful and productive line of independent sales agents who typically have long-standing relationships with clients,” Mr. Chase said. “They sell the deal, and clients get defrauded.”
The SEC did a better job of shutting down what it said was a fraud in the case of Castleberry Financial Services Group after only a year in business. In February, the SEC was granted a temporary restraining order and temporary asset freeze against Castleberry and its principals.
Among other allegations, the SEC said the firm’s president, T. Jonathon Turner, formerly known as Jon Barri Brothers, had falsely claimed to have had extensive finance industry experience, an MBA degree and a law degree, while concealing that he had served 18 years in prison for multiple fraud, theft and forgery felonies.
Attorneys for Castleberry Financial and its executives did not return calls seeking comment.
In 2017, state regulators reported that enforcement actions against unregistered brokers and salespeople increased at a faster pace than actions taken against registered individuals. That means the risk from salespeople on the fringes of the financial advice industry is growing. And they are the type of people who often sell scams that are being marketed as unregistered securities.
“[The] enforcement survey reflects a large increase in enforcement actions against unregistered individuals and firms,” according to an October 2018 report from the North American Securities Administrators Association. Members of the group reported actions in 2017 against 675 unregistered individuals and firms — an increase of 24% over the prior year — and 647 registered individuals and firms — a 9% increase.
“The surge in cases against unregistered actors reversed a two-year trend in which registered individuals and firms in the securities industry, broker-dealers and investment advisers, had constituted the majority of respondents in state enforcement actions,” according to NASAA.
Perhaps the poster boy for selling phony unregistered securities is Barry Kornfeld, a leading seller of the Woodbridge Ponzi scheme.
The SEC barred Mr. Kornfeld from working as a broker in 2009. Regardless, he continued to sell private securities; he and his wife allegedly solicited investors at seminars and a “conservative retirement and income planning class” they taught at a Florida university, according to an SEC complaint.
From 2014 to 2017, he and his wife received $3.7 million in commissions after selling more than $60 million of the Woodbridge private securities, according to the commission. Mr. Kornfeld reached a settlement in January with the SEC, agreeing to be barred for a second time from the securities industry. Robert Harris, a lawyer for Mr. Kornfeld, did not return a call seeking comment.
Registered reps involved
Unregistered reps aren’t the only ones selling fraudulent securities. Registered reps working at broker-dealers also are involved.
“We’re starting to see more sophisticated means for registered reps within the broker-dealer space to get investors to invest in private securities,” Thomas Drogan, senior vice president at Finra, said in testimony last year about investor fraud before the SEC’s Investor Advisory Committee. “The challenge in that space has been reps encouraging their customers, for example, to send money from their brokerage account to their bank account. And once the money gets to the bank account, instructing the customer to then send the money to the individual reps’ outside business activity. This creates a problem. This creates a very big challenge for broker-dealers to conduct surveillance on.”
The practice, known as “selling away,” can be grounds for disciplinary action if the broker-dealer employing the broker has not approved the broker’s actions. Unregistered firms and individual topped the list of disciplinary actions by state securities regulators in 2017.
Advisers at independent broker-dealers are commonly paid 7% commissions when selling private placements, clearly on the high end of a broker’s pay scale.
“What’s driving this?” asked Adam Gana, a plaintiff’s attorney. “It’s commissions, commissions, commissions. Brokers think they can get away with selling whatever they want on the side.”
Even though these dubious private securities are creating havoc for investors and the financial advice industry, regulators may soon change the rules about how private securities transactions are supervised.
Last year, Finra proposed rule changes that are intended to simplify how broker-dealers supervise a hybrid rep’s outside business activity and sale of private securities. The new rule focuses on the rep’s RIA firm and decreases some of the responsibility the broker-dealer has to watch over that separate line of business. It would cut costs for the firm and the broker. But some think these changes could prove dangerous.
William Galvin, secretary of the Commonwealth of Massachusetts and the most feared regulator in the securities industry, does not care for the Finra rule proposal.
“Finra claims that the proposed rule will strengthen investor protections, but it is not at all clear how investors will be protected by the removal of supervisory oversight,” Mr. Galvin wrote in a comment letter last April about the proposed rule. “The absence of proper oversight of outside business activities will increase the risk of fraud and abuse.”
Can financial advisers and the financial advice industry do anything to contain this problem?
Local investment advisers are often the best cops on the beat for detecting such frauds. Their knowledge often comes from clients who are being pitched such deals at “free” steak dinners that are provided to get them in the door for a presentation.
Advisers have the responsibility to report a suspicious private securities deal to their firm, said Mr. Chase, the former SEC attorney.
“If brokers get wind of these types of deals, they’ve got to go to the broker-dealer’s compliance department and report to the SEC or Finra,” he said. “They have the ability and obligation to report. There’s nothing wrong with putting these suspicious deals in front of regulators.”
Whether you’re a first-time investor or have been investing for many years, there are some basic questions you should always ask before you commit your hard-earned money to an investment.
Question 1: Is The Seller Licensed?
Research shows that con-artists are experts at the art of persuasion, often using a variety of influence tactics tailored to the vulnerabilities of their victims. Smart investors check the background of anyone promoting an investment opportunity, even before learning about opportunity itself.
- Researching brokers: Details on a broker’s background and qualifications are available for free on FINRA’s BrokerCheck website.
- Researching investment advisers: The Investment Adviser Public Disclosure website provides information about investment adviser firms registered with the SEC and most state-registered investment adviser firms.
- Researching SEC actions: The SEC Action Lookup – Individuals allows you to look up information about certain individuals who have been named as defendants in SEC federal court actions or respondents in SEC administrative proceedings.
If you are not sure who to contact or have any questions regarding checking the background of an investment professional, call the SEC’s toll-free investor assistance line at (800) 732-0330.
Question 2: Is The Investment Registered?
Any offer or sale of securities must be registered with the SEC or exempt from registration. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
Smart investors always check whether an investment is registered with the SEC by using the SEC’s EDGAR database or contacting the SEC’s toll-free investor assistance line at (800) 732-0330.
Question 3: How Do The Risks Compare With The Potential Rewards?
The potential for greater returns comes with greater risk. Understanding this crucial trade-off between risk and reward can help you separate legitimate opportunities from unlawful schemes.
Investments with greater risk may offer higher potential returns, but they may expose you to greater investment losses. Keep in mind every investment carries some degree of risk and no legitimate investment offers the best of both worlds.
Many investment frauds are pitched as high return opportunities with little or no risk. Ignore these so-called opportunities or, better yet, report them to the SEC.
Question 4: Do You Understand The Investment?
Many successful investors follow this rule of thumb: Never invest in something you don’t understand. Be sure to always read an investment’s prospectus or disclosure statement carefully. If you can’t understand the investment and how it will help you make money, ask a trusted financial professional for help. If you are still confused, you should think twice about investing.
Question 5: Where Can You Turn For Help?
Whether checking out an investment professional, researching an investment, or learning about new products or scams, unbiased information can be a great advantage when it comes to investing wisely. Make a habit of using the information and tools on securities regulators’ websites. If you have a question or concern about an investment, please contact the SEC, FINRA, or your state securities regulator for help.
Editor’s note: This is a repost of an article from the SEC’s
investor education website. I have a more extensive checklist of my top ten ways to avoid getting caught in a financial scam that is still highly relevant today. If you have questions about an investment or knowledge of ongoing fraud please contact me.
Editor’s note: This is re-post of an investor alert that recently appeared on FINRA’s website. This is a good reminder of the need to “trust but verify” the credentials of your investment professional.
FINRA recently issued an investor alert on fraudsters impersonating FINRA executives, offering bogus investment “guarantees” to investors as part of an advance-fee scam. But regulators are not the only ones who need to worry about someone trying to steal their good name.
We are aware of a recent scheme that involved an unregistered individual impersonating a registered investment professional to lure in potential investors. This scammer created a fake version of a public FINRA BrokerCheck® report of a legitimate broker—picking an experienced broker with a spotless regulatory record.
The doctored BrokerCheck report was emailed to potential “clients” using the name and CRD number of a registered investment professional, and a company that is not registered as a broker-dealer with FINRA. The solicitation included other documentation and a request for investors to respond with a photo of their driver’s license and other personal information. Here are some of the red flags we spotted on the doctored report:
Here are six tips to keep your money and personal information safe from these types of scams.
1. Go to the source. FINRA encourages investors to “ask and check” by using BrokerCheck before investing with an investment professional. Don’t assume that the information you receive in an investment pitch is legitimate. Go directly to the sources that collect the regulatory information to produce these reports, including FINRA’s BrokerCheck, the SEC’s Investment Adviser Public Disclosure, and state registration databases. You can search both professionals and firms not only by name, but also by their registration number—known as a CRD number.
2. Look for things that appear out of place. Compare whatever BrokerCheck report or other documentation you receive from an individual or firm soliciting your business with the real reports you obtain yourself from BrokerCheck or the sources in Tip 1. Be wary of typos, and look for differences in the reports. For instance, in a recent scam, the doctored information was in fonts that were different from fonts used in other parts of the report, items appeared to be pasted into the document, and the state of the branch office address was not included in the list of states where the individual was licensed.
3. Verify information with an internet search. Take a few moments to use a common search engine to type in the name of the individual who is soliciting your business and the firm name, and see what comes up. Does it match the information provided to you, including the contact information? If something doesn’t look right, do a little more digging, including a map search on the address or a reverse lookup on the phone number. Be sure to check all this information against a reliable source such as BrokerCheck. When scanning LinkedIn profiles, be aware that scammers often copy select information from a registered person’s LinkedIn profile to create the appearance of legitimacy.
4. Do not send money or personal information without verifying the recipient. In the scam described above, investors were asked to send a driver’s license photo and other personal information in response to an email solicitation. Don’t ever send money or personal information, such as your driver’s license, passport, social security number, date of birth, or bank account information, until you verify who contacted you, as described in Tip 3.
5. Beware of the use of personal contact information. Sometimes a scammer will ask you to send money or personal information to a personal (not firm) email address or to respond to phone numbers that are not listed as official firm contacts. One general rule all investors should follow: if you invest through an account at a financial firm, use BrokerCheck to verify that the firm is registered and send all deposits directly to the financial firm. If an individual pitches an investment opportunity that requires you to write a check directly to him or to a third party, proceed with caution.
6. Be alert to the red flags of fraud. Be cautious of guarantees, unregistered products, overly consistent or high returns, complex strategies, missing documentation, account discrepancies and pushy salespeople. The vast majority of investment professionals are trustworthy individuals, but there are always exceptions who might look to take advantage of your trust. Practice spotting the persuasion tactics that con artists use, and always exercise healthy skepticism. For instance, be wary of sales pitches that make exaggerated claims about performance. This is a red flag of fraud.
If you are suspicious about information you receive from an individual or firm soliciting your business, contact FINRA or another regulator BEFORE you send any personal or financial information. If you are an investment professional and have concerns that someone is using your name or information as part of a potential scam, contact your firm’s compliance department, and alert FINRA by calling our BrokerCheck hotline at (800) 289-9999, or emailing BrokerCheck@finra.org.
Subscribe to FINRA’s The Alert Investor newsletter for more information about saving and investing.
Every week Utah residents lose money by investing with friends, family or neighbors – people they knew and trusted. Investment fraud is a big problem here in Utah, largely because our close-knit communities are a prime target for “affinity fraud.” Our state has a long history of financial scams and Ponzi schemes, many of which have been perpetrated by members of the LDS church on members of their ward or stake. It’s heartbreaking.
I have seen people who borrowed money against their homes or liquidated retirement accounts in order to fund risky investments based on pitch by someone they trusted. Unfortunately by the time they call me, the money is long gone – and so is the person who took the money. Because I specialize in helping people recover losses in investment fraud cases I often get asked for advice on how to avoid needing me. So, at the risk of all my work drying up, here is my TOP TEN ways to avoid investing in a financial scam:
10. Slow down. According to the Insider Monkey blog, many people invest after only hearing the pitch; watch out for promoters who try to commit you on the spot. Don’t do it! Take your time, do your research, ask lots of questions, search the internet, review their financials, visit the company, kick the tires before you buy. Be very wary of aggressive sales pitches and deadlines. Ask the hard questions before you hand over your money, not after.
9. Do your homework. Run a simple Google search on the company and its managers, or the individual. If it involves a company, ask for a private placement memorandum and company financials. Hire an attorney to evaluate the investment and help you perform due diligence. Attorneys have access to court databases to look for lawsuits and bankruptcies. Contact federal and state securities regulators see if actions have previously been taken against the company or individuals involved.
8. Hire an attorney. Attorneys can be expensive, but it is much cheaper to hire an attorney to document the transaction properly on the front end than to sue the bad guys when it all blows up. A good lawyer can help you perform due diligence on the company and individuals, and can determine whether the investment is properly structured as a private offering and complies with state and federal statutes. Your lawyer can review the offering materials and help you understand what the risks are. Hiring a good attorney up front is an investment in your investment.
7. Get it in writing. I am amazed how often people will give hundreds of thousands of dollars to someone on nothing more than a handshake. Don’t do it! If things go bad later, proper documentation will be critical to me in my efforts to get your money back. The terms of your deal should always be put in writing, and those terms should be reviewed by the competent attorney you hired. (See number 8.) In any private investment opportunity you should receive a detailed lengthy disclosure document called a private placement memorandum (PPM). Take the time to review it before you invest. It contains detailed information about all aspects of the business including the business model, financial history, risk factors, biographical information on the managers, civil lawsuits, and the terms and conditions of the investment, among other things. If the company soliciting your money has not prepared a PPM, that should be the end of your discussions with them.
6. Beware of guarantees. If anyone tells you that your investment is “guaranteed” that should cause some you concern. All investments carry risk, and personal guarantees (especially oral ones) are rarely a means to get your money back. Even if you are approached to loan money and get a promissory note that is usually still considered to be an investment, and such loans can be very risky if not properly secured. If you are told that the loan or investment is “secured” hire an attorney to document the security interest and verify the collateral. (See Number 8.)
5. Beware of secret trading strategies, offshore investments, commodity or currency (FOREX) trading, futures, options and minerals. This could be an article all by itself. Generally, avoid anyone who credits a highly complex or secretive investing technique or touts unusual success. Legitimate professionals should be able to explain clearly what they are doing and how they make money. And if the individual is really making as much money with their strategy as they say they are, they shouldn’t need yours. These types of “alternative” investments nearly always involve extremely high risk, despite what you are told.
4. Work through licensed stock brokers or investment advisors. Even when investing in a private (unregistered) opportunity ask whether the promoter is licensed to sell you the investment, which regulator issued that license and whether the license has ever been revoked or suspended. A legitimate securities salesperson must be properly licensed under most circumstances. If you have any questions contact the Utah Division of Securities at (801) 530-6600.
3. Don’t invest with friends and neighbors. It may seem like doing business with someone you know and trust would be safer, but that is simply not true. All investing involves risk, and just because you trust the individual soliciting the investment does not mean that the investment itself is good. Trust but verify; and if things go badly do not hesitate to aggressively protect your interests.
2. Keep church out of investing. If someone pitching you an investment casually mentions that they used to be the bishop or in some other church position, watch out! Church callings and temple worthiness are not relevant to investment decisions, so beware of those who bring these issues up in an investment pitch.
1. If it sounds too good to be true it probably is. If you are thinking about putting money into an alternative, unregistered, or unregulated investment that promises abnormally high returns, watch out. The fact that others may have been getting their promised returns does not mean you will. All Ponzi Schemes eventually implode, and you may be left holding the bag.
Note: I wrote this article for The Enterprise and it was published in their July 2014 issue. Because their content is only available to subscribers I am posting it here.
Copyright 2014 by Mark W. Pugsley. All rights reserved.
*This article is intended to address private investments, not those made through a licensed stock broker or registered investment advisor.
The vast majority of interactions between investors and investment professionals are positive. However, sometimes the relationship doesn’t go as planned, and the situation can’t be resolved by communicating directly with your firm or broker. In such a situation, you may find yourself considering arbitration or mediation.
There are many factors to consider as you proceed down these paths, one of which is whether to hire an attorney to help you out.
An attorney that represents you during arbitration or mediation proceedings can provide experience, direction and advice. Brokerage firms are generally represented by an attorney in an arbitration proceeding, so even if you choose not to hire an attorney, there might be one representing the firm or individual on the other side.
Securities Arbitration Basics
Arbitration is similar to going to court, but is usually faster, cheaper and less complex than litigation. It is a formal alternative to litigation: two or more parties select a neutral third party, called an arbitrator, to resolve a dispute.
The arbitration process goes something like this. A FINRA arbitrator or panel (consisting of three arbitrators) will listen to the arguments set forth by the parties, study the testimonial or documentary evidence, and then render a decision. The arbitrator’s decision, called an award, is final and binding, and all parties must abide by the award. FINRA does not have an appeals process through which a party may challenge an award. However, under federal and state laws, there are limited grounds on which a court may hear a party’s motion to vacate an award.
The size of the claim will determine how the arbitration process works. Claims involving more than $100,000 require an in-person hearing decided by a panel of three arbitrators, with one chairing the hearing. Smaller claims up to $50,000 can be decided by a single arbitrator in one of three ways: a regular hearing where evidence is presented in person; a phone hearing that incorporates many aspects of a standard arbitration hearing; or a “paper” hearing where an arbitrator makes a decision based solely on the documents submitted.
To Hire or Not to Hire
FINRA’s Code of Arbitration Procedure states that parties are entitled to be represented by an attorney at any stage of the arbitration proceeding. Here are some things to consider when you are trying to decide whether to hire an attorney to represent you in securities arbitration or mediation.
- The process governing arbitration proceedings will likely be unfamiliar to you. Hiring an attorney with experience in these matters might be a comfort to you and help you appropriately present your case to the arbitrators.
- Arbitration can be faster, less expensive and more streamlined than litigation, but some arbitrations involve complex legal and regulatory issues or large claims for monetary damages. You might benefit from legal guidance if your case falls into these categories.
- An attorney can provide guidance even before the arbitration process begins. An experienced attorney can assist aggrieved parties in determining whether they have a viable claim for arbitration. This can be critical so that parties do not waste money or time filing a case that does not have a good chance for success.
- FINRA provides identical randomly-generated lists of proposed arbitrators to both parties, along with a detailed report on each arbitrator’s background. An attorney can help you evaluate which arbitrators might be a better fit for your case.
- Parties to an arbitration can come to the forum with a lot of emotion about what has transpired to this point. An attorney can serve as a detached third-party representative and provide legal advice to help you meet your goals.
- Speaking with an attorney is confidential and protected by attorney-client privilege. This means that your attorney is not allowed to discuss what you tell him or her with anyone else, and that statements you make will be kept between the two of you. Attorney-client privilege helps both parties better understand the strengths and weaknesses of the case and establishes a relationship of trust that can lead to better guidance and decision-making.
- If you cannot afford an attorney, some law schools provide legal representation through securities arbitration clinics. Under faculty supervision, law students provide legal services and guidance on the arbitration process in disputes between individual investors and their investment professionals.
A word about non-attorney representatives or NARs. Although NAR firms are an alternative to representation by attorneys, NAR firms are not subject to the same professional rules or guidelines, nor are they subject to malpractice insurance requirements. Investors may also not be aware of the absence of these protections, and therefore may not properly evaluate the benefits and costs of representation by NAR firms.
Finding an Attorney
Whether you decide to engage an attorney or not, a good resource to consult is An Investor’s Guide to Securities Industry Disputes published by The PACE Law School Investor Rights Clinic.
If you decide hiring an attorney is the right choice for you, the first step to take is to locate qualified candidates. The Securities and Exchange Commission (SEC) offers these tips:
- Consult with your own attorney, if you have one, about your situation and whether you would benefit by an attorney who specializes in securities arbitration or litigation.
- Contact the American Bar Association and the Public Investors Arbitration Bar Association (PIABA). Both allow you to search their member attorney directories for someone to represent you in your area. PIABA members have specific experience representing investors in disputes with the securities industry.
You can also check with your state, county or city bar associations.
If you cannot afford an attorney, some law schools provide legal representation through securities arbitration clinics. Under faculty supervision, law students provide legal services and guidance on the arbitration process in disputes between individual investors and their investment professionals.
Ask These Questions
Picking the right attorney is a personal decision that is often unique to your own needs and preferences. It’s a good idea to interview more than one attorney—and ask the following questions:
Do you have experience representing investors in securities arbitrations? Experience matters. Representation by someone with specialized legal knowledge of the investments sold to you and the procedures that apply to the arbitration process are important. Ask how long the attorney has been in business and how many securities arbitration cases he or she has handled.
How will you represent my interests? Aggrieved investors commonly do not understand, or cannot articulate, the extent of their harm. A critical component to effective representation is your attorney’s ability to communicate to you, the opposing counsel and, ultimately, the arbitration panel any underlying problems with the investments or actions at issue. Your attorney should also be expected to articulate the regulatory standards your investment professional is held to, and how those standards were breached.
How are you paid? Attorneys are paid under different arrangements. Many attorneys who specialize in representing investors in securities arbitrations do so on a contingent fee basis. This means the attorney is willing to advance their time with the hope and expectation of recovering money from the investment firm or professional. Read the fee agreement presented by the attorney to make sure that you understand the terms.
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I have represented a number of doctors and dentists over the years in disputes with their stockbrokers and in Ponzi schemes and investment fraud cases.
My medical professional clients are typically intelligent and savvy with respect to managing their money, but because they are often too busy to dig into the details they can often be taken advantage of by unscrupulous investment advisors, and in some cases, they fall victim to fraud.
Below are a couple of war stories. Of course, most investment professionals are good and well-qualified – but not all of them. A keen intellect cannot substitute for taking the time to read the documents carefully. The devil may really be in the details
The Falls Event Centers
Utah-based entrepreneur Steve Down had been pitching investments in The Falls Event Centers since 2011. He raised approximately $120 million from more than 300 investors – the majority of whom are dentists throughout the United States.
On May 11, 2018 Down and his event centers were sued by the Securities and Exchange Commission for defrauding investors.
So why did so many dentists fall for this scheme? How did he do it?
Steve Down is a gregarious 61-year-old promoter who billed himself as an “an innovative entrepreneur and successful business owner, is passionate about creating companies and providing jobs.”
One of Mr. Down’s companies was called CE Select, a continuing education provider for dentists. According to the detailed complaint filed by the SEC, dentists attending CE Select seminars were pitched an investment in The Falls during their lunch break.
I honestly cannot figure out how he managed to make a pitch for a wedding reception center investment seem like a normal part of a dental continuing education seminar. But I digress.
The investment was basically a hard-money loan to fund the purchase and construction of more event centers and was supposed to pay returns of 10 to 14% per year to investors.
Down’s investment pitch remained essentially the same for years. The SEC alleged that Down made the following representations to his captive audience of unsuspecting dentists:
- The Falls had 8 profitable locations and was growing at a rapid pace,
- The Falls would have 200 event centers by 2022
- After The Falls had 12 centers, it would be able to obtain institutional loans to replace the hard money loans,
- Many of the event centers were profitable even before they opened, because they were accepting event bookings before they opened, and continued to be profitable after they opened,
- Each event center would earn gross revenues of $1 million per year and cover expenses of approximately $650,000, leaving a profit of approximately $350,000, or 35% of revenue, per year.
- The 200 projected centers would bring in net income of $70 million per year.
- The Falls would be worth $2.8 billion by the time it had 200 centers in 2022.
The problem, according to the SEC, is that many of these representations were false, and Down allegedly knew it.
The Falls’ own accounting records showed that the event centers had never been profitable. Down also allegedly knew that his business model was unsustainable because of crippling debts owed to investors and mortgage holders. But he nevertheless kept on pitching this “profitable” investment to dentists and other investors until the SEC finally shut him down.
Down did not admit or deny the allegations in the SEC’s complaint, but he and The Falls did consent to the entry of a final judgment permanently enjoining them from future violations of securities laws and Down paid a civil penalty of $150,000. A final judgment was entered against Down and The Falls on May 11, 2018, by United States District Court Judge Jill Parrish.
Despite all this, according to an article in the local paper, Down planned to continue building his wedding center empire, and “The Falls will continue to conduct business as usual.”
But that won’t happen – The Falls filed for bankruptcy soon thereafter.
What do you think? Have you been a victim of investment fraud? Why do you think doctors often fall prey to fraudulent investments? Comment below!
Imagine waking up one day and discovering that all of your retirement savings were gone; all the money you had been working to save had evaporated in a poof.
That’s what happened to over 200 people on November 15th. They had invested in a “Silver Pool” investment promoted by Gaylen Rust who claimed he had inside information about the silver market and told investors he was consistently making returns of 25 to 40% per year. He claimed that investor money would be used to purchase and store silver bars, and that he had never lost money in his trading.
People bought into this Silver Pool investment and recommended it to their family and friends. And after watching their investment increase (on paper) many “doubled down” and put all of their retirement money with him.
After all, Rust was an active, respected member of the Church of Jesus Christ of Latter Day Saints and a generous promoter of music education in the schools. What could go wrong?
Well, as it turns out plenty.
On November 13, 2018 the Commodities Futures Trading Commission (CFTC) and the Utah Division of Securities jointly filed a lawsuit against Gaylen Rust and his company Rust Rare Coin, Inc. The SEC filed a similar lawsuit a few days later. The filing of simultaneous, obviously coordinated lawsuits by three different securities regulators is quite rare in this state, and is indicative of the size and seriousness of the case.
The state and federal regulators have alleged that Gaylen Rust has been “engaged in a massive scheme to defraud” and has been running a Ponzi scheme since 2008. He raised over $200 million from investors in the last 5 years alone, and now it’s gone.
If true, this will be one of the largest Ponzi schemes in Utah history.
I have been getting calls from investors, regulators and former Rust employees over the last few weeks and almost all of them are stunned by this news. Gaylen Rust and his father Alvin have maintained a good reputation in the rare coin and precious metals industry in Utah for many years. Alvin Rust was an avid coin collector and started Rust Rare Coin in 1966 as a way to combine his hobby with his livelihood. Rust Rare Coin was known as a reputable place to purchase gold and silver coins, even after Alvin got caught up in some ill-fated deals with Mark Hoffman years ago.
According to the allegations in the CFTC Complaint, Rust and his company began promoting a “Silver Pool” in 2008 as a way for people to invest in the silver market, which Rust probably seemed to understand quite well:
“[Rust] told investors and prospective investors that they would sell silver held in the pool as market prices rose and buy silver for the pool as market prices fell; thereby increasing the amount of silver held in the Silver Pool, as well as the value of each investor’s share in that pool. [Rust] told investors and prospective investors in the Silver Pool that by trading silver in this manner, they generated extraordinarily high returns, averaging twenty to twenty-five percent per year and sometimes as high as forty percent per year or more.”
Consistent returns of 25% to 40% per year?? A simple Google search would have shown that trading commodities is extremely risky. How did he achieve such consistent profitability? The simple answer is that he didn’t. Potential investors should have been skeptical of those consistently high returns, but most trusted him and did not attempt to verify the claims Gaylen Rust was making. My opinion is that if any investment claims to achieve returns of 15% or more per year you should be extremely careful.
Shockingly, Rust didn’t provide investors with any paperwork setting forth the terms of the investment, he didn’t formally disclose his financials, and he didn’t provide any risk disclosures. All of those should have been huge red flags to any investor.
Once he had their money, Rust sent out “account statements” via email showing impressive (but unfortunately fake) returns on their investments. Rust purportedly claimed that he had as much as $80 million dollars of silver bars stored at Brink’s depositories in Salt Lake City and Los Angeles, and that this reserves would permit investors to liquidate their investments at any time.
How much silver is that? One source told me that $80 million in silver would fill five semi-trucks. That’s a lot of silver, but unfortunately Brinks depositories aren’t big enough to hold that much silver. Not good.
According to the CFTC complaint, Rust did not use investor money to purchase silver or silver contracts for the Silver Pool as he had represented. Instead, investor’s retirement money went to make payments to other investors, to fund other affiliated Rust Companies, and to pay personal expenses for the Rust family.
Rust never even had a commodities trading account at HSBC Bank, and was never licensed as a broker or commodities trader.
It was all a big scam.
The Prospects for Recovery
One of the first questions I invariably get from victims in a case such as this is: “What are the chances of recovering of my retirement losses?”
Unfortunately, they are not great in this case, as in most Ponzi scheme cases. It is exceedingly rare to recover all of your losses from a Ponzi scheme.
The CFTC case (which is the main case) has been assigned to United States District Judge Tena Campbell who is a highly respected jurist here in Utah. Based on the CFTC’s motion Judge Campbell has selected Jonathan Hafen to serve as the receiver in this case and he will work under the direction of the Court along with several lawyers in his firm, including Joe Covey who will be lead litigation counsel.
Because I am not involved in that aspect of the case and only have access to the public filings I cannot predict how much money will ultimately be recovered. Mr. Hafen has stated in open court that there are no significant assets to recover, which is not a good sign.
Mr. Hafen’s job will be to gather assets from any sources he can, and then to distribute those assets in an equitable manner to the victims. You can learn more about how an SEC receivership works here. The latest filings and information about the case can be found on the Receiver’s website: https://rustrarecoinreceiver.com/.
Unfortunately, one of his primary tasks will be to file clawback lawsuits against investors who got their money out before the whole scheme collapsed. So if you are one of the lucky investors who got out you should expect a demand letter from the receiver within a year. It’s a good idea to hire an attorney to handle that clawback case; preferably one who understands the process.
Complex receiverships such as this are extremely expensive and can stay open for years, depending on how long to takes to pull together and then distribute all of the assets. The Vescor case involving Val Southwick took ten years to complete, which led understandable criticism of the receivership process.
The only winners in this process are the lawyers.
How To Avoid Getting Scammed
This is a tragic story that is repeated over and over in our state, and most of these scams take advantage (intentionally or not) of the relationships of trust that members of the LDS Church have with one another. This is commonly called “affinity fraud.” Our state has a long history of financial scams and Ponzi schemes, many of which have been perpetrated by members of the LDS church on members of their ward or stake. It’s heartbreaking to say, but Utah has one of the highest rates of fraud per capita of any state in the country.
I specialize in helping people recover losses from investment fraud, but by the time people call me the money is usually long gone – and so is the person who took the money. So here are a few tips to avoid getting sucked into an investment scam:
- Slow down. Take your time, do your research, ask lots of questions, search the internet, review their financials, visit the company, kick the tires before you buy. Be very wary of aggressive sales pitches and deadlines. Ask the hard questions before you hand over your money, not after.
- Do your homework. Run a simple Google search on the company and its managers, or the individual. If it involves a company, ask for a private placement memorandum and company financials. Contact federal and state securities regulators see if actions have previously been taken against the company or individuals involved. The local office of the SEC can be reached at 801-524-5796, or you can call the Utah Division of Securities at (801) 530-6600.
- Hire an attorney. Attorneys can be expensive, but it is much cheaper to hire an attorney to document the transaction properly on the front end than to sue the bad guys when it all blows up. A good lawyer can help you perform due diligence on the company and individuals, and can determine whether the investment is properly structured as a private offering and complies with state and federal statutes.
- Get it in writing. I am amazed how often people will give hundreds of thousands of dollars to someone on nothing more than a handshake. The terms of your deal should always be put in writing, and those terms should be reviewed by the competent attorney you hired.
- Beware of guarantees. If anyone tells you that your investment is “guaranteed” that should be a red flag. All investments carry risk, and personal guarantees (especially oral ones) are rarely a means to get your money back.
- Beware of secret trading strategies, offshore investments, commodity or currency (FOREX) trading, futures, options and minerals. Avoid investing with anyone who claims to have a secretive investing algorithm or touts unusual success. These types of investments nearly always involve extremely high risk, despite what you may be told.
- Work through licensed stock brokers or investment advisors. Even when investing in a private (unregistered) opportunity ask whether the promoter is licensed to sell securities, which is required under most circumstances. Run their name through FINRA’s Broker Check
- Don’t invest with friends and neighbors. It may seem like doing business with someone you know and trust would be safer, but that is simply not true. All investing involves risk, and just because you trust the individual soliciting the investment does not mean that the investment itself is good. Trust but verify; and if things go badly do not hesitate to aggressively protect your interests.
- Keep church out of it. If someone pitching you an investment casually mentions that they used to be the bishop or in some other church position, watch out! Church activity or high callings are not relevant to investment decisions, and if anyone mentions their church position as part of an investment pitch warning bells should be going off.
- If it sounds too good to be true it probably is. If you are thinking about putting money into an alternative, unregistered, or unregulated investment that promises abnormally high returns, watch out.
Copyright © 2018 by Mark W. Pugsley. All rights reserved.